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Playing Ball in the People's Republic

Editor's note: TheStreet.com's Ronna Abramson takes a look at the risks and rewards of investing in the booming economy of China. She also looks at
IBM's venture capital plans
and how
Microsoft aims
to gain a toehold there.

Just say the word "China," and investors and companies seem to start frothing at the mouth these days.

But be careful, because investing in China is not for the faint of heart. While the opportunities in a developing nation of 1.3 billion are undoubtedly mammoth, don't forget this is a Communist country, and consequently it presents some unique risks, seasoned experts caution.

"Investors beware," said Lip-Bu Tan, founder of the venture capital fund Walden International, which has been investing in China since 1994. "I think there is some hype here. People get too overexcited by China."

Start with
Baidu.com(BIDU - Get Report), a company with operating cash flow of $4.5 million that was quickly crowned the
Google(GOOG - Get Report) of China. As if living up to its name, Baidu's stock soared to a dizzying $122.54 on the first day of trading -- $95.54 above the price it was sold at by underwriters.

"Clearly there's a lot of hedge funds and retail buyers that get excited about China and a search engine like Google, but this is a very small company," Tan said. Apparently, investors started coming back to their senses, because the stock has recently declined to the $82 range.

Similarly, Tan argued that
Yahoo!'s(YHOO - Get Report) subsequent $1 billion investment for a 40% stake in Chinese e-commerce company
Alibaba was way too high. But that deal may only feed the Chinese frenzy.

As Piper Jaffray senior analyst Safa Rashtchy noted earlier this month: "A major deal like Yahoo!-Alibaba is an endorsement of what otherwise might seem to be risky or unproven areas, and thus, investors are likely to feel more comfortable investing in the Chinese Internet sector."

Economies of Scale

Tan acknowledged the growth potential for Internet companies in China, noting some projections that the Chinese Internet population will surpass that of the U.S. within eight years. But he warns that the risk of government intervention is "very high."